TIPS & LINKS: Understanding Compound Interest

When you understand the true magic of compound interest and you have time on your side, then you can make sound financial decisions throughout your life.

The two magic variables to compound interest are TIME and RATE OF RETURN. Let’s look at these examples. We hope they springboard your motivation to fast track your debt repayments, build that savings buffer or put that extra bit away into super…

Compound Interest & Fast Tracking Debt Repayment

Did you know… If you have $3,500 owing on your credit card paying 21.5% interest and you are paying off minimum payments of $70 a month – it will take you 90 years and 1 month to pay off and you’ll pay a total of $27,050 interest! Even if you just pay a little extra each month, say $150. You can pay it off in two years 8 months and pay $1,074 interest. Earn more, spend less or use savings to get rid of credit card debt ASAP so you can start focusing on your exciting goals ahead.

Compound Interest & Building Your Superannuation Nest Egg

Say you’re 25 years old and you can access your super when you’re 65 years of age. You have $1,000 in your super fund currently and are earning $65,000 a year contributing 9.5% of your annual salary, being $6,175. Did you know… If you receive 5% returns, you’ll retire on $752, 979. If you receive 6% returns you’ll retire on $965, 941. If you receive 7% returns you’ll retire on $1,247,721. We can’t change the timeframe with super but we can influence our rate of return. Login to your super fund and check if you’re in a conservative (more cash, less shares, property) or high growth (less cash, more shares, property) investing option. When you have time on your side to reduce risk by riding the highs and lows, you could make yourself a cheeky extra half mill – just from logging in and choosing the right investment mix option.

Compound Interest & Starting Saving When You Have Time On Your Side

Check out how starting a savings plan early in her life benefitted Kit.

So START NOW. It’s never too late or too early. Use time on your side and let compound interest do the work for you.

PS if you want another example, just to really show the power of this stuff, check out Barefoot Investor Scott Pape’s‘Letter To My Second Born’ below. Like us, Scott is a massive fan of starting the basics early and letting compound interest play it’s game over time.

A Letter to My Second-Born

You’re seven hours old.

As I sit here beside your crib, typing ever-so-quietly, sneaking a look every so often at your squished-up face (hey, it’s been a rough day), I can’t get over that you’re just so … new. Baby, you’ve got something that everyone wants a lot more of.

Time.

You see, most people run out of time.

I see it every day in my job: I try and convince young people about just how powerful their lives could be (they don’t believe me). I spend the rest of my day trying to help older people who are desperately trying to make up for lost time. They’re racing against the clock.

Yet here’s the thing: if you have time, you don’t have to race. You don’t need to nervously check stock prices every day. You don’t have financial pressure. You don’t need the stock market to “do something”. You don’t get suckered into get-rich-quick schemes. You don’t freak out when the market crashes.

You can make time work for you.

And, as your dad, it’s my job to show you how to do it.

So, I’m going to give you a bunch of money, a fancy car, and a Lear jet.

I’m joking! (Look how well that turned out for Justin Bieber.) My old man didn’t give me a silver spoon, and you won’t get one from me either. Instead, I’m going to give you a couple of life lessons that’ll boost your self-worth (and your net worth).

The Joy of Hard Work

Every week for over a decade, I’ve written this newspaper column.

They pay me the same money whether I bash something out in an hour, or a day.

Last week I ended up spending two days researching, interviewing and writing a column about how money can trap women into staying in violent relationships. I put my heart and soul into those 987 words.

And it paid off. That article was shared by thousands of people. But, more importantly, I received some incredibly personal, heartwarming, even tragic emails from women who needed to hear that message of hope: that they weren’t alone. That something could be done for them and their kids.

There’s a special joy in hard work. In doing a good job and delivering on your promises.

The Miracle of Compound Interest

Now, let’s talk about the simplest and safest way to create your fortune: compound interest.

As you’ll learn, there are many, many things your old man can’t do (Mum will fill you in later). But the one thing I have in my favour is the ability to steadfastly stick to a plan.

I don’t just know compound interest works — I’ve lived it.

And you can too.

With enough time, you can’t help but build enormous wealth. The truth is, your greatest investment weapon isn’t a high IQ, a knack for numbers, or fancy letters after your name: it’s time. And the sooner you start, the better. Take a look at this chart (see box), which tells the story of you and your mate.

Let’s say that at age 15 you start working on the family farm.

(You’ll get your own paddock, a ram and a ewe — sex education and financial literacy all rolled into one).

You work incredibly hard, scrape together $5,000 a year and invest it in a basic share fund. You reinvest your dividends for the next 10 years. Along the way you earn a nominal 10 per cent (for the past 30 years shares have actually returned 10.8 per cent a year … but not in a straight line).

And then you stop.

Your mate doesn’t start as early as you. He waits until he gets a real job — at age 25 — before he starts investing. Like you, he puts in $5,000 a year, but unlike you, he doesn’t stop. He keeps on investing every year until he’s 60 years old.

All up, you put in $50,000. He puts in $180,000.

So you’d think he’d have more than you, right?

Wrong. Even though you’ve only put in less than one-third the money, you end up with over 50 per cent more! (You get $2,709,000 — he gets $1,645,000).

That’s the power of compound interest. That’s the power of time.

This isn’t a new thing. It’s not hit and miss. It works every single time, and it’s the safest and surest way to become incredibly wealthy. So why don’t more people do it?

Well, because it’s kinda … boring.

Most people don’t even do the $5,000.

(People will ALWAYS find a reason to play it safe and do nothing. Those people will ALWAYS be broke).

Those who do invest will often check their returns after three years, feel they’re getting nowhere, and decide to ‘diversify’ into a Honda Jazz, a trip to Bali and an iPhone 98.

(The reality is that most people learn about compound interest in reverse — by buying stuff they don’t need, with money they don’t have, to impress people they don’t care about. Yet debt robs them of their financial independence. Debt makes things more expensive. Ultimately, debt is slavery).

Hardly anyone makes it to the seventh year, which is when the compounding snowball really starts.

Yet if you can stick with it, that’s when your life changes. The money starts pouring in gushes. That’s when you’ll crack the time code. And that’s when you can truly ‘tread your own path’.

Happy Birthday!

P.S And just think for a moment, Edward, what the returns would be if you didn’t stop at 25!

Resource Hub

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When you understand the true magic of compound interest and you have time on your side, then you can make sound financial decisions throughout your life. The two magic variables to compound interest are TIME and RATE OF RETURN. We hope these examples springboard your motivation to fast track your debt repayments, build that savings buffer or put that extra bit away into investments…

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FRIENDLY DISCLAIMER: 10thousandgirl does not provide financial advice. Participants should consider obtaining independent advice before making any financial decisions. 10thousandgirl's objective is to create the time and space for women to build money confidence – so you feel in control when making decisions and seeking advice.